This article originally appeared on The Financially Independent Millennial and was republished with permission.
The views and opinions expressed in this article are those of the author only and are not endorsed by Credit.com.
Investors nearing retirement have different needs than investors with many years remaining in the workforce. Retiring means losing the regular paycheck from work, and as a result, replacing that income is a key consideration. There are many investments that appeal to retirement investors, such as purchasing quality dividend stocks like the Dividend Aristocrats. But there are also many investments that retirement investors should stay away from. Retirement investors should avoid the following 16 investments.
“Cash is king” is a well-known phrase, but when it comes to retirement investing, cash is hardly king. Cash should be avoided by retirement investors because it earns no return. In stark contrast to bonds which pay interest or stocks that pay dividends, cash earns no interest. As a result, cash loses value over time due to the steady erosion of inflation.
While retirees have a number of pressing challenges to pay for expenses without a paycheck from working, keeping a great deal of cash on the sidelines is not the best idea. Ideally, retirees can generate enough income from their investments, in combination with other sources of income such as Social Security so that they do not need to hold a large amount in cash.
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#2: High-Yield Bonds
Sometimes referred to as junk bonds, high yield bonds are fixed income securities issued by companies with sub-investment grade credit ratings.
With interest rates still near historic lows, fixed-income yields have plunged over the past several years. As an example, the 10-year Treasury yields just 1.3% right now. With inflation running significantly above this level, retirees will see their purchasing power erode with low-yielding bonds.
Because of this, high yield bonds are appealing due to their higher yields. But investors may be reaching for significantly elevated risk in their search for yield. Bonds with below-investment grade credit ratings have a higher likelihood of default.
Read more: Can You Retire at 62 With 300k?
Cryptocurrencies like bitcoin are all the rage these days. The massive rise in the value of bitcoin and other cryptocurrencies over the past few years is enticing for any investor. And cryptocurrency gets a lot of coverage in the financial media.
But retirees need to remember that volatility is a two-way street. The price of bitcoin has declined by nearly 50% from its 52-week high, a reminder that any investment can lose value. Bitcoin also does not pay interest or dividends, meaning investors will not generate income from their investment. And another reason retirees should avoid Bitcoin is simply the higher level of risk involved in buying cryptocurrencies, not to mention the tax implications.
#4: Oil & Gas Royalty Trusts
Oil and gas royalty trusts are niche securities within the stock market. These are companies that own oil and gas-producing properties. Investors receive distributions depending on how much income the trusts generate from these properties. Some well-known oil and gas royalty trusts include BP Prudhoe Bay Royalty Trust (BPH) and Permian Basin Royalty Trust (PBT).
As with any group, not all royalty trusts are bad investments. But the risks are high across the board—royalty trusts are essentially a bet on underlying commodity prices. Investors also have to face the prospect that reserves will decline faster than the trust had originally anticipated.
If oil and gas prices fall, share prices of the royalty trusts collapse, and their distributions decline, often to zero as occurred in 2020 during the coronavirus pandemic.
#5: Mortgage REITs
Real Estate Investment Trusts, also referred to as REITs, are a great way for retirees to earn higher levels of investment income. Many REITs have strong yields of 4% or more. Retirees might be tempted to buy mortgage REITs, a subset of the asset class that typically offers even higher yields.
Indeed, many REITs have double-digit yields in excess of 10%. But in many cases, sky-high yields are an indication of elevated risks, and mortgage REITs are no different. Mortgage REITs are extremely complex, financially architected business models that are not easy to understand, making them relatively poor choices for most retirees. In addition, mortgage REIT share prices and their dividend payouts can swing wildly based on changes in the yield curve.
Every few years or so, gold gets a lot of attention in the media, usually because the price of gold has risen over a certain period of time. But for retirees interested in generating sustainable income from their investments, gold should be avoided.
Gold pays no dividends or interest, which is why it is not attractive for many retirees. To quote legendary investor Warren Buffett on gold: “The idea of digging something up out of the ground, in South Africa or someplace and then transporting it to the United States and putting it into the ground, in the Federal Reserve of New York, does not strike me as a terrific asset.”
Some gold stocks like Barrick Gold (GOLD) do pay dividends, but their dividend track records are highly inconsistent. Many gold stocks have cut their dividends when precious metals prices decline.
#7: Momentum Stocks
Momentum stocks are those that have captured investors’ attention, most often due to a rapid rise in their share price. This causes other investors to jump in, perhaps because of a fear of missing out, which can push share prices even higher. But in many cases, momentum stocks fall back down to Earth, as their underlying fundamentals may not justify the rallying share price.
Momentum stocks that have gotten a lot of attention in the financial media in recent months include GameStop (GME), AMC (AMC), and more. In all cases, their share prices skyrocketed in a relatively short period of time. But retirees should resist the urge to buy momentum stocks, as they can be highly volatile and almost never pay dividends.
#8: Microcap Stocks
Stocks can be classified according to their market capitalizations, which is simply the current share price multiplied by the number of shares outstanding. Large-cap stocks have market caps above $10 billion, while small-cap stocks have market caps below $2 billion, with midcaps in between these ranges.
The smallest group of stocks is known as microcaps. These are stocks with market caps below $100 million. Microcaps are very small businesses, their stocks generally have low liquidity, and many are in questionable financial condition. As a result, retirees should stick to midcaps and large caps.
#9: Stocks With Too Much Debt
Debt is a big concern for income investors such as retirees. Stocks with bloated balance sheets and too much debt are at high risk of cutting or suspending their dividends during recessions. Profits may decline substantially when the economy enters a downturn, but debt still needs to be repaid.
Stocks with excessive debt have high-interest expenses that may force them to cut their dividends. This is of particular concern when it comes to high-yield Master Limited Partnerships, many of which have leverage ratios above 5x.
Therefore, retirees could generate dividend income with other tech stocks like Apple (AAPL), Microsoft (MSFT) or Cisco (CSCO).
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